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Bubbles and Crises

  • Allen, Franklin
  • Gale, Douglas

In recent financial crises a bubble, in which asset prices rise, is followed by a collapse and widespread default. Bubbles are caused by agency relationships in the banking sector. Investors use money borrowed from banks to invest in risky assets, which are relatively attractive because investors can avoid losses in low payoff states by defaulting on the loan. This risk shifting leads investors to bid up the asset prices. Risk can originate in both the real and financial sectors. Financial fragility occurs when positive credit expansion is insufficient to prevent a crisis.

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Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 110 (2000)
Issue (Month): 460 (January)
Pages: 236-55

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Handle: RePEc:ecj:econjl:v:110:y:2000:i:460:p:236-55
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  1. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
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  10. Weil, Philippe, 1987. "Confidence and the Real Value of Money in an Overlapping Generations Economy," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 1-22, February.
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